Friday 29 Mar 2024
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This article first appeared in The Edge Malaysia Weekly on August 10, 2020 - August 16, 2020

IN the aftermath of the 2008 global financial crisis, it took 1½ years for Bank Negara Malaysia to start raising the overnight policy rate (OPR) from a low of 2%.

This year, the devastating effects of the coronavirus outbreak and ensuing Movement Control Order (MCO) have led to a cumulative cut of 125 basis points (bps) to the key interest rate, to a record low of 1.75% currently.

Given the resurgence of Covid-19 cases globally, can the already fragile world economy take another hit? How long can we expect the historically low interest rates to stay?

The move to cut interest rates is necessary to revive our weak economy. The Malaysian economy is forecast to see a contraction of 3.8% in a worst-case scenario while the most optimistic projection is a growth of 0.5%.

To cushion the economic fallout of the ongoing pandemic, the government has rolled out the Short-term Economic Recovery Plan (Penjana) and Prihatin Rakyat Economic Stimulus Package (Prihatin).

Economists generally expect the OPR to start rising in the second half of next year, when the economy has demonstrated firmer growth in the first half. “Economic indicators are pointing to some recovery by 4Q2020, with better numbers in 2021. So, it is unlikely for the OPR to stay low for a long time,” Affin Hwang Investment Bank Bhd chief economist and head of research Alan Tan tells The Edge.

Sunway University economics professor Dr Yeah Kim Leng concurs, saying that the country will be on track to achieve a stronger growth in the first half of 2021. Thus, there is an expectation that a tightening could be seen in the second half of next year.

Yeah warns that any premature rise in interest rates may derail the economic recovery. “Central banks are on the conservative side given the uncertain recovery. So, right now, we may continue to see low interest rates.”

Anthony Dass, AmBank Research head/chief economist and a member of the Economic Action Council Secretariat, opines that there is room for another 25bps cut to the OPR next month in view of the uncertain global economic environment.

While the monetary easing is favourable for the economy, depositors bear the brunt of it as the returns from their bank savings accounts are being eroded. “In the short term, it is a necessary sacrifice by depositors for the greater good of the economy. That has been the fundamental economic principle to stimulate the economy,” says Yeah.

He notes that handouts by the government will help alleviate the people’s financial distress. “Money is being put in the pockets of low-income households. In the short term, it is a win-win situation.”

Despite that, the negative repercussions of prolonged low interest rates should not be ignored as they could result in speculative and unproductive investments. “In the short term, people will take on too much risk in various asset classes, leading to an unsustainable rise in stock prices,” says Yeah, noting that the rapid escalation of asset prices, in turn, will increase the risk of asset bubbles.

Over the long term, the structural issue of misallocation of resources will emerge as a result of low interest rates for an extended period of time. For example, the market may see lower investments in technology and factories, even though interest rate cuts are meant to revive the economy by boosting consumption and investment.

Malaysian Rating Corp Bhd chief economist Nor Zahidi Alias says the main concern in a prolonged period of low interest rates is a distortion in the pricing of risks. “In other words, there tends to be a general underpricing of risks, which encourages more risk-taking behaviour. This will lead to a build-up in asset prices, which will encourage the formation of financial imbalances. This, in turn, will increase the vulnerability of the real economy.

“Even now, we can see asset prices are already surging (for example, in the equity market, the MSCI World Index is up 47% while the MSCI EM Index is up 46% since their troughs in March) because massive amounts of liquidity are being injected into the global economy.”

But what will be the impact of prolonged low interest rates on you and other stakeholders?

Consumers

For consumers and retirees, their accumulation of savings has been affected and they will have to think of ways to make up the shortfall.

Although Malaysia has been in a deflationary mode since March, many people have been struggling with the rising cost of living. In June, the consumer price index (CPI) declined 1.9% from a year earlier, led by a drop in the transport component on lower fuel prices.

A change in spending behaviour can be expected, with more savings set aside for emergency use. “Consumer spending will be reduced as we are likely to see an increase in savings. Whether this is a long-term effect will depend on the speed of the recovery,” says Yeah.

“People need to build up a pool of savings to enable them to ride through any economic shocks. It is healthy given that the future generation will have adequate savings to protect against any unexpected economic or financial shocks, including layoffs. The behaviour will likely last for a few years.”

He notes that investment portfolio diversification is crucial to mitigate any underlying risks and retirees could explore higher-yielding but slightly riskier investments such as high-quality money market funds, real estate investment trusts and other types of unit trusts. “With the Employees Provident Fund (EPF) declaring consistently good returns, it would be prudent for retirees to keep their savings there instead of moving their money to riskier investments,” he adds.

Meanwhile, Max Growth Wealth Education Sdn Bhd managing director Nicholas Chu suggests that depositors park their money in their EPF accounts as the returns provided by the provident fund are still higher than those of fixed deposits.

EPF declared a total dividend of RM45.82 billion for 2019 (5.45% or RM41.68 billion for conventional savings and 5% or RM4.14 billion for shariah savings). It only needs to deliver at least a nominal dividend of 2.5% and beat inflation by at least 2% on a rolling three-year basis.

Economist Lee Heng Guie, executive director of the Associated Chinese Chambers of Commerce and Industry of Malaysia’s (ACCCIM) Socio-Economic Research Centre (SERC), says it is time to reevaluate our investment income portfolio (savings, rental income and retirement savings) and determine whether there will be enough of a cash buffer to sustain our spending during a prolonged economic downturn.

“The prospect of a prolonged period of lower interest rates may put retirees in a bind. They have to contend with less growth for their ‘safe money’ or consider taking on more equity risk. But retirees should be cautious about chasing yields to keep up with retirement costs,” he adds.

UOB Research senior economist Julia Goh recommends that savers and those with excess funds who are keen to participate in the country’s post-recovery efforts to consider the RM500 million Prihatin Sukuk, which will be issued by the Ministry of Finance in the third quarter. “The sharp rise in domestic retail participation in the stock market suggests that savers are looking for alternative ways to increase returns in a low interest rate environment,” she says.

According to Goh, the deposit base of individuals was close to RM770 billion as at May. This works out to 38% of the total deposit base and about 40% of households’ liquid financial assets.

Borrowers

For borrowers, interest rate cuts are definitely good news as the borrowing cost has become lower.

Yeah says the low interest rate environment is conducive for financing property purchases, provided that one has stable earnings and the financial capability to service the long-term debt obligation. “A lower debt repayment means the borrower’s disposable income is higher or the debt-servicing period can be shortened.

“While the prevailing interest rate may be low, it will rise when the economy recovers and inflation rears its ugly head. Borrowers with variable or flexible interest rates should be mindful of the rising interest rate risk and factor such increases into their long-term personal finance and budget plans.”

Malaysia’s overall banking system loan applications jumped 45% month on month (m-o-m) in June, when the Recovery Movement Control Order (RMCO) was imposed from June 10 to Aug 31, replacing the previous Conditional Movement Control Order (CMCO). The loan applications were underpinned by demand from households (up 133% m-o-m) while the business segment saw a m-o-m decline of 7%.

Total loans growth came in at 4.1% year on year (y-o-y) in June, slightly higher than the 3.9% y-o-y expansion in May. Kenanga Research says it remains to be seen if such levels of loan applications and approvals can be sustained in the coming months.

For the household segment, the rise in loan applications was across the board.

Total loan approvals surged 66% m-o-m, with household and business loan approvals rising 110% and 41% m-o-m respectively.

AmBank Research’s Dass notes that while loan applications are likely to pick up, it need not necessarily be fully converted into approvals due to the policies and procedures put in place by banks to ensure that borrowers meet the requirements. “This would also mean there is a negative relationship between interest rates and bank risk-taking in a low interest rate environment.”

MARC’s Nor Zahidi doubts whether banks would be willing to supply credit as they will be extra cautious about the condition of their balance sheets going forward.

Yeah is of the view that loan growth will remain subdued due to rising unemployment. “We still see some credit rationing. For individuals who are in sectors that are showing signs of distress, the possibility of retrenchment will deter banks from lending and individuals from taking on long-term debt.”

He reminds borrowers to ensure that they can sustain loan repayment before making any debt obligations. “Banks have become more selective now. They will take a cautious approach in lending. Low interest rates tend to result in excessive borrowing and lowering of credit standards,” he points out.

SERC’s Lee urges the public to do proper financial planning before taking a home loan and keep a monthly loan commitment of not more than one-third of their net income.

Meanwhile, Max Growth’s Chu advises borrowers not to be too optimistic and to be prepared for the worst-case scenario. “For example, you may think of lower car prices because of the sales tax exemption. But the important thing is whether you have the repayment capability. When you buy a property, make sure you have the repayment capability for the next 6 to 12 months. The worst has not happened yet as this is still the loan moratorium period.”

Businesses

With the OPR at a historical low of 1.75%, businesses that have substantial amounts of cash in the bank may be thinking of ways to best increase their returns and spread these to other investment options that offer higher yields.

It could also be an opportune time for businesses looking to expand to take up new loans. However, with the pandemic raging and economies around the world dipping into a recession, chances are that there is only a handful of businesses considering expansion now.

That said, many businesses are turning more cautious in terms of committing to new borrowings during this economic downturn. Instead, they are seeking refinancing and restructuring of existing loans to manage their debt levels.

During the global financial crisis, total business loans outstanding only expanded 2.6% in 2009 compared with 13.2% in 2008. Disbursements of loans to businesses and issuance of private debt securities for new activities also slowed during that period as demand for business financing weakened.

Nevertheless, if interest rates are kept low for a long time, economists say it could harm long-term financial and macroeconomic stability. Cheap borrowing tends to encourage risk-taking activities. If they are not careful, businesses — as well as households — could find themselves in too much debt or beyond their financial capability while neglecting opportunities to deleverage.

One way to prevent unsustainable debt levels among corporates is for the central bank to raise interest rates as soon as macroeconomic conditions allow, says SERC’s Lee. “Macroprudential policy tools must be in place to limit too rapid credit growth and the build-up of financial imbalances.”

During the Asian financial crisis, corporate debt levels shot up to 131% in 1998, a significant portion of which was foreign debt. Things unravelled after the ringgit tanked to a low of 4.9 against the US dollar in 1997, resulting in a ballooning of foreign debt and corporate defaults, which created a banking crisis.

It should be worth noting that much has changed since. Malaysia has undergone deep structural reforms to prevent such shocks from happening again.

MARC’s Nor Zahidi says Bank Negara Malaysia’s macroprudential policies have been effective in preventing corporate debt from escalating to dangerous levels. The most recent statistics show that corporate borrowings have eased from 103% of GDP to 99% in 2019, with domestic corporate debt accounting for 75% of GDP.

“While elevated, corporate indebtedness is not as dire going into the pandemic crisis, with the debt-to-equity ratio hovering around 25% and an interest coverage ratio of 4.6 times,” says Yeah.

He adds that it is worth noting that since interest rates had been brought down sharply since January, corporate loans growth was sustained at about 5% from April to June. “It is more reflective of an improvement in bank credit flows and sustained economic recovery rather than excessive corporate borrowing, which would have been the case if the loans growth had been maintained at a much higher rate over a longer period.”

Government

In the efforts to repair the damage inflicted by Covid-19 and to revive the economy, the government has embarked on a behemoth fiscal stimulus of RM295 billion while the central bank has utilised its monetary policy tools.

Of the RM295 billion stimulus, RM45 billion — equivalent to 3% of GDP — requires direct fiscal spending. And it is no secret that the government will eventually need to borrow to revive the economy.

Some have estimated that the government could borrow RM20 billion or more than what it would have already borrowed in the absence of the pandemic. Direct federal government debt stood at RM823.79 billion as at end-March — higher than the RM793 billion as at end-2019.

The low interest rate environment could come in handy now. Bond yields have been shifting downwards and this means the government will be able to borrow and refinance at a lower cost.

Yeah believes that the government can seize the opportunity to restructure its liabilities to reduce the debt-servicing cost and optimise the debt structure and composition. “For instance, converting high-cost indirect borrowings into direct debt or retiring more expensive foreign currency debt with domestic ringgit bonds,” he says.

It will also give the government a more conducive environment to raise long-term debt to finance long-term infrastructure projects, which of course will be subject to a prudent debt level ceiling and debt servicing limits, says Yeah.

However, Nor Zahidi points out that as the government has to deal with high debt and concerns of international credit agencies, it may not necessarily want to borrow substantially more.

Just last week, Finance Minister Tengku Datuk Seri Zafrul Abdul Aziz tabled the Temporary Measures for Government Financing (Coronavirus Disease 2019) Bill 2020, which will seek to raise the self-imposed statutory debt limit of 55% of GDP to 60%, among others. Notably, this statutory debt limit refers only to direct federal government debt. As at June, it stood at 53.2% of GDP.

It is worth noting that countries around the world are accumulating higher levels of debt in the wake of the pandemic as they undertake measures to save lives and jobs. The International Monetary Fund’s Fiscal Monitor in April highlighted that the average public debt of advanced economies had plateaued at about 100% of GDP in the 2010s compared with 74% in 2007, but it is now set to rise substantially as a result of the crisis.

In emerging markets and developing economies, the IMF notes that public debt has risen steadily. “The pandemic and its economic consequences will cause a major increase in fiscal deficits and public debt ratios across countries,” notes the report.

The IMF also projects the overall fiscal deficits to widen more in advanced economies than in emerging markets and developing economies, partly reflecting a more pronounced projected economic contraction in advanced economies.

The general government debt globally is estimated to increase 13% to reach 96.4% of GDP this year from 83.3% in 2019.

 

 

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